Oil prices and U.S. Treasury yields have demonstrated their closest alignment since the Gulf War in 1990, reflecting the growing impact of the ongoing Middle East conflict on global financial markets. The correlation between West Texas Intermediate (WTI) crude prices and the yield on 10-year U.S. Treasury notes reached approximately 65 percent this month, a level approaching the record high of 66 percent observed during Iraq’s invasion of Kuwait nearly four decades ago.

This strong relationship underscores how the conflict, centered on tensions involving Iran, is influencing broader economic expectations, particularly through concerns over energy supplies passing through the Strait of Hormuz, a critical chokepoint for roughly 20 percent of the world’s oil exports. The volatility in oil prices amid the conflict—from swings above $100 per barrel to around $70—has prompted investors to re-evaluate their strategies, with energy market developments increasingly dictating bond market movements.

Typically, investors in government debt focus heavily on economic indicators and central bank policy updates. However, in recent months, the influence of oil prices on bond yields has overshadowed these traditional factors. Mike Riddell, portfolio manager at Fidelity International, noted that market participants have effectively adopted an oil trader’s perspective when assessing Treasury yields.

The synchronized movement extends beyond the United States, with European government bond yields also rising in tandem with oil prices, especially in countries more exposed to the energy shock. Richard Woolnough of M&G characterized the trend as yields moving “tick-for-tick” with oil prices this year.

The U.S. 10-year Treasury yield, a key benchmark for global borrowing costs, has climbed to levels not seen since 2007, driven by a combination of the geopolitical risks stemming from the U.S.-Iran crisis and a robust domestic economy. Rising energy prices have heightened inflation concerns, leading investors to anticipate more aggressive interest rate increases by the Federal Reserve. Analysts from TS Lombard estimate that each additional dollar increase in WTI crude corresponds to nearly 0.02 percentage points added to the 10-year yield. For instance, on a recent trading day, oil prices jumped by as much as 4.5 percent while Treasury yields rose by up to 0.09 percentage points.

As the conflict continues, investor expectations have shifted away from the notion that central banks might overlook short-term inflation spikes related to energy supply disruptions. Instead, the sustained rise in oil prices is seen as compounding inflationary pressures, influencing monetary policy decisions. Fed Chair Kevin Warsh recently reaffirmed concerns that inflation remains persistently high, coinciding with the first U.S. interest rate increase since 2023.

Peter Schaffrik, global macro strategist at RBC Capital Markets, identified energy prices as a primary driver of central bank policy this year, outpacing traditional growth and inflation metrics in importance for bond markets. However, some investors caution that the transmission channels linking oil prices to bond yields are complex and create challenges for timing market moves, as noted by Lauren van Biljon of Allspring Global Investments.

Mandy Xu of Cboe suggested that if the current pattern persists, the trajectory of Treasury yields may hinge more on developments in Iran than on Federal Reserve actions. In Europe, the surge in natural gas prices—up 160 percent this year—has also heightened inflation risks, prompting the European Central Bank to cite energy cost increases as a factor influencing its recent rate hike. ECB President Christine Lagarde has drawn attention to rising gas prices as an upside risk to inflation during the ongoing geopolitical crisis.

Meanwhile, prospects for a resolution to the conflict remain unclear. Former U.S. President Donald Trump recently rejected Iran’s proposal for a new seven-day ceasefire. Market strategists, including those at JPMorgan, acknowledge the heightened uncertainty, with no clear consensus on how the situation will develop or how to forecast the ultimate impact on oil prices. This lack of predictability presents ongoing challenges for investors in markets closely tied to energy and interest rates.